Download 20140416 Budgeting and Macro Policy

Budgeting and Macro Policy
J. Bradford DeLong
April 16, 2014
Unemployment
Inflation
John Maynard Keynes (1924)
• We see, therefore, that rising prices [inflation] and
falling prices [deflation] each have their
characteristic disadvantage. The Inflation which
causes the former means Injustice to individuals
and to classes--particularly to investors; and is
therefore unfavorable to saving. The Deflation
which causes falling prices means Impoverishment
to labor and to enterprise by leading
entrepreneurs to restrict production, in their
endeavor to avoid loss to themselves; and is
therefore disastrous to employment....
John Maynard Keynes (1924)
• Thus Inflation is unjust and Deflation is
inexpedient. Of the two, perhaps Deflation is, if
we rule out exaggerated inflations such as that of
Germany [in 1923-1924], the worse; because it is
worse, in an impoverished world, to provoke
unemployment than to disappoint the rentier.
But it is not necessary that we should weight one
evil against the other. It is easier to agree that
both are evils to be shunned…
Growth
Deficits and the Economy
• Macroeconomists work in three runs:
– Short run
• Productive capabilities of the economy do not change
significantly, prices do not fully adjust. Production can deviate
from potential output.
– Medium run
• Short-run deviations of production from potential output are
ironed out. Prices adjust so inflation finds its level. Economy
grows.
– Long run
• Government debt must be paid back (or at least balanced— or
defaulted upon
Questions About “Runs”
• What is the time frame appropriate for each
“run”?
• How do we stitch the conclusions reached by
analyzing different “runs” togethere?
The Short Run: The Quantity Theory of
Money
• Start with the quantity theory of money:
– PY= MV
• Federal Reserve controls the money supply M
• In normal times:
– People want to spend the money in their pockets (and bank
accounts) by buying stuff at a rate V
– If PY too small relative to trend, Federal Reserve pushes M up—
and so Y (production and employment) jumps up and P (inflation)
accelerates.
– If PY too large relative to trend, Federal Reserve pushes M down—
and so Y (production and employment) falls and P (inflation)
decelerates.
– If the rest of the government does something that disturbs this
relationship, the Federal Reserve can and does neutralize it
• Hence fiscal policy should be “classical” rather than “macroeconomic”
The Short Run: But These Times Aren’t
Normal
• The quantity theory of money:
– PY= MV
• What determines V? Why do people want to spend their
money?
• Because holding your wealth in money rather than
bonds is expensive: you are losing interest.
• But what if, in the aftermath of a financial crisis, the
short-term interest rate on bonds goes to 0?
• Then you would rather hold money than bonds: money
is safer
• And the Federal Reserve loses its ability to control the
flow of spending
The Short Run: What Is to Be Done?
• Normally the Federal Reserve boosts the money supply,
and people spend more
• The Federal Reserve can try all kinds of expedients—nonstandard monetary policy—to try to cajole people into
spending more
• Or the government can spend more: the government’s
money is, as far as buying stuff, as good as anybody else’s
– So in the short run—which lasts as long as unemployment is
substantially elevated—the government should spend more
– And perhaps the government should tax less as a way of
cajoling private-sector households to spend more—but that is
less certain and sure
Are We Doing This? No!
Are We Doing This? No!
The Short Run: How Long Will It Last?
The Short Run: How Long Will It Last?
How Long Does the Short Run Last?
• Six years ago, I would have bet serious money
that the “short run” is a couple of years—three
at most.
• Now? We are already six years into a “lost
decade”. And Japan is now 28 years into its
post-Plaza “readjustment”…
• When will the “medium run” arrive?
Reconciliation of Unemployment and
Employment Views
• The transformation of cyclical into structural unemployment
• Come 2016, we may no longer be able to use policies to
boost employment and production without incurring
unacceptable increases in inflation
• Why? Because once people have dropped out of the labor
force, it may be hard to get them back.
• Each month that the strong recovery we have been waiting
for is delayed:
– We lose $100 billion in useful commodities we would be
producing at full employment, but aren’t.
– We lose $267 billion because the fact that people are dropping
out of the labor force means that our future booms will be weaker
The Medium Run
• Someday elevated unemployment will end
– Then Y = Y*
• The equation we then want to look at is the fullemployment national income identity
– Y* = C(Y-T) + I + G + X
• If we boost G, we should then also take steps to reduce C
by raising T
• If not, then I will fall
• And if I falls, growth over a ten-year span will fall
• And right now it looks as though we don’t have economic
growth to spare
• Don’t cut the parts of G that produce economic growth!
• Don’t worry about budget balance until the medium-run
comes!
The Medium Run: Debt and Deficits
Is There a Medium-Run Problem?: 10-Year
Nominal Treasury Rates
The Shadow Cast by the Lesser Depression
The Shadow Cast by the Lesser Depression II
Medium-Term Choices
Medium-Term Choices II
The Long Run: Choices to Make
Is There a Long-Run Problem?
• What if our politics remains broken?
– “Fiscal dominance”
– “Financial repression”
– Exorbitant privilege: the U.S. governmente as
Renaissance Medici Bank
• What are our long-run political options?
– Pensions, education, health care
– Climate change, inequality, intellectual property,
robots
Is There a Long-Run Problem? II
Beyond 2025…
• Stick to PAYGO, no problem…
– Milton Friedman’s “A Program for Fiscal Stability”
proposal in the early post-WWII years that no
government spending program be passed without a
funding source
• If we continue to elect the Republican Party we
have had since 1980—well then we have a big
problem
And at Some Point the Bond Market
Vigilantes May Show Up…
But We Don’t Have to Worry Until After 2025,
Right? Right?